Bitcoin and Virtual Currencies – The point of view of a lawyer

published on February 7, 2018

  

This past year bitcoin has had its momentum within the mainstream audience mainly due to the exponential growth of its price in Q3 and Q4 of 2017, which registered a positive trend flowing from approximately USD 1.000, - in May to roughly USD 14.000, - in late December. 1

Such a price surge has brought up a relatively niche topic to the mainstream audience as to cause the term “bitcoin” to be listed as the second of the biggest global news stories in 2017 by Google Trends, 2 and governments have been rushing up on the discussion of legal issues and regulations of virtual currencies, involving tax regimes, as well as money laundering and exchangers shifting money from one user to another through ad hoc software broadly reminiscent of traditional trading platforms.


  

However, the popularity of bitcoin has not turned into a general confidence on handling the topic due to the legal, economic, as well as technological competences needed to fully understand the way bitcoin and the other (more than a thousand) virtual currencies actually work.

In the following text we aim to frame a general overview of the matter, trying to provide a comprehensive definition of cryptocurrencies and to propose a comparative analysis of virtual currency and traditional fiat money.
  

Ontological Definition

The main hurdle to get over with, as to understand cryptocurrencies, is the lack of an autonomous ontological definition from a mere tech explanation of the matter since bitcoin is actually comparable to an mp4 file (i.e. not more than a 0-1 binary code sequence) as any other .pdf, a picture or a movie, stored digitally in our devices.
 

Due to the intrinsic digital nature of cryptocurrencies, they can be stored in a software (wallet) installed in a personal computer, an external hard drive, as well as through an online based cloud service; and for further, although cryptocurrencies can be easily transferred, they can also be easily lost whether the device used as a wallet unfaulty get broken or the log in needed information are forgotten by the user.

 

Thus, trying to give a substantial definition of bitcoin (something further than “it is a file”) would be similar to the definition of the Colosseum as a pile of rubble: ontological correctness lacking a fully comprehensible explanation.

 

Teleological Definition

1. Background

A conceivable option may be the framing of a teleological definition of cryptocurrencies such as “virtual currency”; but as to fully understand the purpose of cryptocurrencies - which is at the basis of a teleological view - a brief background on its genesis is needed.

  

As a starting point, cryptocurrencies might be traced back to a paper titled “b-money, an anonymous, distributed electronic cash system”, 3 which was self-published in 1998 by Wei Dai, a computer engineer member of what is known as “Cypherpunks electronic mailing list”, an informal online based group advocating the use of cryptography as to achieve privacy and security.4

  

With his whitepaper, Wei Dai may be considered as the forerunner of virtual currencies: he was who originally introduced the concept of an anonymous digital currency5 to be implemented through a protocol in which “untraceable pseudonymous entities [. . .] cooperate with each other more efficiently, by providing them with a medium of exchange and a method of enforcing contracts”6 where government involvement had to be “permanently forbidden and permanently unnecessary”.7

  

Although Wei Dai's b-money has never been implemented, the concept of an anonymous currency was later recalled by Satoshi Nakamoto, the enigmatic creator of bitcoin.

  

In fact, in 2008 Satoshi Nakamoto self-published a white paper titled “Bitcoin: A Peer-to-Peer Electronic Cash System”8, which recalls concepts introduced in Wei Dai's white paper such as the definition of bitcoin as a not-hierarchical electronic payment system between users that voluntarily share their files.

   

The white paper distinguishes between bitcoin (lowercase), which refers to the cryptocurrency itself, and Bitcoin (capital) as to define the system which runs the cryptocurrency.
 

The idea proposed by Nakamoto aims at the developing of a payment system entirely free from trusted third parties connected to any Government, which implies the need for the system to operate transactions between users without a middle entity certifying the security, uniqueness and irreversibility of the transaction itself.

  

The need identified by Nakamoto, which the bitcoin - as well as the other cryptocurrencies - aims to fulfill, was the need for a payment system not based on the users relying on a third party, but on the security that cryptography can provide: in other words, a medium of exchange to substitute fiat money: a new form of currency.

  

This are the basis to elaborate a teleological definition of bitcoin and all the other cryptocurrencies: a new form of currency meant as a medium of exchange as to replace fiat money. Nevertheless, it must be questioned whether such new medium of exchange meant to substitute fiat money falls within the traditional concept of money.

  

2. Relation with Money

Economics have thought us how money is the main medium of exchange for the purchase of goods and services and for the payment of debts.

 

Generally, money has three main functions: medium of exchange, unit of account and store of value. As a medium of exchange, money is used to purchase goods and services, while as a unit of account money enables a user to measure the exchange and market value of the goods and services therein, other than enabling to measure the value of all transactions. Finally, as a store of value, money enables the user to transfer resources (i.e. purchasing power) from the present day to the future.

  

The main function of money is its attitude to function as a payment instrument (i.e. medium of exchange) since the other two functions are either a consequence either a positive condition of the first function. As the Nobel prize winner Paul Samuelson once said, money, being opposite to commodities, is not demanded due to its intrinsic value, but due to the goods that can be purchased with it. In other words, nobody would accept money in exchange for goods if that money could not furtherly enable the purchase of other goods.
 

At the present time, the use of money for the sales and the extinction of pecuniary obligations is granted by a collective trust, which is regulated and recognized under the law; money becomes actual fiat money only once it is backed up by a Government.
 

It goes without saying that, as to determine whether virtual currencies, perhaps the bitcoin, can actually be considered equal to a money, references must be made to the three abovementioned functions of currencies.
 

As a medium of exchange, bitcoin and all the other virtual currencies fulfill such function; on the other hands, virtual currencies differ from money on two aspects: a former one is the fact that they are used on the mere voluntary basis of the users, who are not obliged to accept them; and a latter on,e that is connected to the implementation system, which enable way faster and cheaper transactions. 9 For further, being transactions with virtual currencies irreversible, they cannot be contested.
 

As a unit of account, there are several online platforms which provide real time prices of virtual currencies enabling sellers to fix prices and consumer to estimate their purchasing options. On the other hand, it must be noticed that virtual currencies prices are extremely volatile, which is surely an attitude that limits their ability to be used as unit of account.
 

Finally, at the present time it is quite clear that virtual currencies could not act as a store of value (intended in the traditional sense) due to the extreme price volatility, which mines the key feature as to fulfill such function: stability grants that the value of a currency today could turn into purchasing power in the future.
 

EU Definition

In 2015, the European Central Bank released a report on virtual currencies, which is contrary to reckon virtual currencies as “money”, due to the fact that although they may be used as a medium of exchange, they lack a government acknowledgment of the extinguishing function of pecuniary obligation.10

Of course, within the Italian legal system bitcoin and virtual currencies do not fulfill the proper obligation extinguishing function of money under art. 1277 of the Italian Civil Code11 due to the fact that they are not assimilable to fiat money comprising physical money (banknotes or coins), banking money12 (such as a check) and electronic money (as an instrument of monetary circulation), which all falls under the direct or indirect control of the Government. 13 
 

If the definition of virtual currencies such as “quasi-money”, as provided by the value holder of traditional fiat money (BCE and government), is somehow unsatisfactory, it is worth trying to give a much more practical definition.

  

If the virtual currencies are not issued by the Government and the value has not been fixed nor regulated by a central authority, but by the users transacting the virtual currency, it needed to figure out what is the actual basis for the trust of the unicity and irreversibility of the transaction itself.

  

Henceforth, the risk of double spending is avoided by the use of temporary and decentralized servers and their computational power as to record the proof of the transactions' chronological order, which is available to all users accepting such virtual currencies.
  

Blockchain

The technology at the basis of the whole system, which is used to validate the transaction is the blockchain.

Such technology can be described as a record of transactions, which shall necessarily be comprised within this record as to be validated.
 

As a mean to avoid the need of a central authority or a third trusted party to validate the transactions, such record is not stored in a single physical support, as it may be a single server, but the storage takes place in all devices connected to the system itself: these devices are called “nodes”, which act as servers connecting to the system and sharing their computational power for the record of transactions made with a single virtual currency.
 

Each transaction cannot be copied nor modified due to the fact that the blockchain relies on cryptography. Particularly, it relies on what is known as asymmetric cryptography, which is based on transaction performed through the issuance of two “keys”: a private one, alike to a password to be kept secret and a public one, which is shared between the users interested in the transaction.
 

The system requires that the receiving user provides the public key to the transferrer; as to transfer the virtual currency, the transferrer shall add up its private key to the public one; hence, the transferrer will be dispossessed of its virtual currencies and later on the receiving user, signing in with its private key will receive the virtual currency and he would have the disposal of them. 
 

The devices called miners aimed at the record of transactions provide computational power as to permanently and irreversibly record the public and part of the private keys within one block of the blockchain which will be available to all the servers connected to the system.

 

Final remarks

As a final remark, bitcoin and virtual currencies can be considered as a new payment system born from the intuition of an individual (Wei Dai) seeking to create an effective medium of exchange as to substitute fiat money, completely free from trusted third parties and such intuition seems to have been implemented in quite an effective way so far.
 

The “quasi-money” has born and it grants new effective, rapid and cheap exchanges between globally based users sharing the view at the basis of virtual currencies such as not to rely on middle men nor public authorities to validate the transactions.
 

Nevertheless, due to the large spread of the use of bitcoin as a medium of exchange, an overwhelming demand has developed in the past year, as compared to the number of bitcoins available on the market; the effect is a large speculation on the bitcoin value, which effects the other two functions of the traditional fiat money (unit of account and store of value).
 

Negative effects are clearly noticeable: a surge of bitcoin value and an appalling volatility. On the other hands, such negative effects are recoverable: on the former issue, the Chicago Stock Exchange issued financial instruments (futures) in 2017 as to minimize term sales of bitcoins, while on the latter issue of volatility, many real-world transactions with bitcoin are accepted with the use of fiat money as unit of account.
 

For further, the growth of electronic transactions and consequent consume of energy needed to record thus validate is excessively demonized: new algorithm will benefit bitcoin as to be transferred with the use of fewer energy and, truth be told, many new virtual currencies are turning into low-energy schemes.

At the same time, national regulators have undertaken a season of discussion on possible legal issues and perspective on virtual currencies, particularly on matters involving tax aspects, as well as money laundering and providers of virtual currencies services (exchangers) as a way to implement consumer protection against possible financial risks.
 

Yet, a comprehensive regulation seems to be a long way to go, even due to the global aspect of the phenomenon and its partial autonomy from any national and supranational authority.

It may be suggested that the right approach as to discuss on bitcoin and virtual currencies is a profound awareness of the matter and the spread of knowledge to the actual and potential users: all of us.

We will keep publishing articles proposing overviews of the subject matter, with a next one to be focused on the regulatory developments that have taken place in the past years, particularly on tax regimes, anti-money laundering and exchangers regulation.
 

1https://www.statista.com/statistics/326707/bitcoin-price-index/ (ultimo accesso: 26 gennaio 2018);

2https://trends.google.com/trends/yis/2017/GLOBAL/ (ultimo accesso: 26 gennaio 2018);

3 Wei Dai, b-money, an anonymous, distributed electronic cash system, 1998, available at http://www.weidai.com/bmoney.txt (1 February 2018)

4  See http://www.cypherpunks.to/ (1 February 2018)

5  Id., 2 (1 February 2018);

6  Id., 13 (1 February 2018);

7  Id., 1 (1 February 2018);

8 Satoshi Nakamoto,Bitcoin: A Peer-to-Peer Electronic Cash System, 2009, available at http://www.bitcoin.org/bitcoin.pdf (1 February 2018);

9 i.e. there is not a central authority to be remunerates, transaction costs shall cover the mining expenses and due to the digital natura of virtual currencies, there is not need of storage and transport.

10 “Virtual currency can be defined as a digital representation of value, not issued by a central bank, credit institution or e-money institution, which, in some circumstances, can be used as an alternative to money.” BCE, Virtual Currencies Scheme, 2015.

11 Art. 1277, c.c., comma I, “debts shall be extinguished with fiat money within the country at the moment of payment and based on its nominal value”.

12 Cass. civ. Sez. Unite, 04/06/2010, n. 13658, stated that the obligation extinguishing attitude of checks likely to banknotes.

13 Before EU directives were released on the subject matter, some scholars have suggested that debt could only be extinguished through fiat money (see SCIARRONE ALIMBRANDI “L'interposizione della banca nell' inadempimento dell'obbligazione pecuniaria”, Milano. 1977, e L. Farenga “La moneta bancaria”, Torino, 1977, quotedby GIULIANO LEMME e SALA PELLUSO, “Criptomoneta e distacco della moneta legale: il caso bitcoin”, Rivista di diritto bancario, n. 11/2016.)

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